BANCASSURANCE

BACKGROUND
Bank deregulation is changing the face of the financial
services in India.
Deregulation has increased competition thereby creating
excessive pressure on the banking system by narrowing
the interest spread.
Commercial banks have expand their activities beyond
the traditional functions.
Bancussrance helps the bankers to venture into
insurance avenues.

INSURANCE - FEATURES
Generates fee based income.
Scope for business
Large under-served market with relatively less
efficient distribution system
Branch network has high fixed cost.
Banks by utilizing network more productively can venture
into other services such as insurance.
Apply wider range of activities to gain the economies of
scope.

ADVANTAGE TO BANKERS
The proximity and knowledge about their customers
Depositors and Borrowers
Banks control of insurance business
European countries, between 20% to 40%
US market merely 1%

BANCASSURANCE IN OTHER
COUNTRIES
Restriction on the extent to which banks could engage in
domestic life insurance activities curtails US banks.
Banks capitalize on the long-term savings and pension
strength of insurers in European banks.
Insurers are attracted by bancassurance due to the
possibility of gaining short-term deposits.

BANCASSURANCE
Bancassurance allows banks and insurance companies
to hold significant ownership stakes in one another.
Bancassurance is enforced through a legislation by the
Government.
Bancassurance legislation differs from country to
country.
No country allows the bank and the insurer to combine in
a single legal entity and remain controlled by their own
respective regulatory agency.

BANKING & INSURANCE: KEY

DIFFERENCE
Core function in insurance is to intermediate risk itself.
The risk in this service must be well managed
Bearing the risk itself is the service provided by the
insurance company
Core function in banking is to intermediate between
lenders and borrowers
Banks acquire risk as a consequence of conducting
the banking function rather than being intrinsically the
same as that function
Banking function is to be managed well because it is
risky

INSURANCE COMPANY
Insurers liabilities: Capital adequacy in relation to the
proportion of risk assumed by the insurance company

RISK IN INSURANCE SECTOR

Adaptive control cycle
Gather data, make assumptions, set appropriate terms
and conditions for policies
Classify and rate risks
Assess experience against expectation and adapt
practices and rates accordingly

RISK IN INSURANCE SECTOR

Principle of risk diversification: Insurance companies
charge premiums that spread the number of expected
claims across a large number of policy holders
commensurate with their contribution to the overall
exposure and draw upon the collective pool of premiums
to meet actual claims.
The number of independent risks increases.
The overall risk becomes more stable when considered
as a proportion of expected number of claims.

RISK IN INSURANCE SECTOR

Claim Risk: The fundamental risk in insurance is not
being able to meet claims because of the variability of
the number of claims. It is necessary for insurers to hold
capital adequately for the risk they face.
Insurers set premiums that reflect not only the expected
risk but also a margin to accommodate contingencies
and to provide an economic return on the capital.

RISK IN INSURANCE SECTOR

Diverse nature of risks that are insured give rise to the need
for appropriate risk classification.
Insurance market consists of two kinds of customers
Low risk
High risk
Risk differential do not result in pooling equilibrium when both
the risk classes pay the same premium for the same
coverage.
Equilibrium can only be reached by separating these two
kinds of risks.

PRICING COMPARISON
A bank sets rates on its lending and deposit products by
taking into account its cost of funds and expense
margins and fees without any distinction between
acquisition and service activities.
Life insurance, by contrast, involves looking at and
separately keeping track of each group of business for
each investment and insurance product type. It
distinguishes between the acquisition and other costs.

RISKS IN BANCASSURANCE

Credit Risk
Concentration Risk
Liquidity Risk
Realization Risk
Operational Risk
Market Risk
Interest Rate Risk (Re-pricing, Yield Curve, Basis and
Options)

REGULATION AND CAPITAL ADEQUACY

Difficulty in regulation and supervision arises primarily
because despite the complementary nature of the two
types of products, the nature of business and risk that
banks and insurance companies face are very different.
Bank and insurance supervisors have different
definitions of capital and different solvency and liquidity
requirements.

REGULATION AND CAPITAL ADEQUACY

Solvency in insurance is concerned with meeting
obligations and capital adequacy is concerned with the
ongoing business of the insurer and its ability to fulfill
policy holders expectations.
Capital adequacy standard in insurance is less
prescriptive and reflects actuarial judgment more than
that for solvency.

REGULATION AND CAPITAL ADEQUACY

In 1999 a tripartite group of banking, insurance and
security regulators from G-10 countries produced a
report The supervision of Financial Conglomerates
The main issue addressed is that it is possible for the
entities in a group to fulfill their capital requirements on
an individual basis, but for the group as a whole to have
less own funds than the sum of its parts.

REGULATION AND CAPITAL ADEQUACY

The group suggested four quantitative techniques to
assess capital adequacy
Building Block Prudential Approach
Risk Based Aggregation
Total Deduction
Risk Based Deduction

BUILDING BLOCK PRUDENTIAL

APPROACH
In building block approach, the consolidated balance
sheet of the group is split according to type of business.
Capital requirements are calculated by each supervisor
and added together.
This is then compared with the aggregated own funds of
the group.
If the consolidated balance sheet is not available, capital
requirements of individual companies are computed and
added up and then compared with group capital.

BUILDING BLOCK PRUDENTIAL

APPROACH
As the intra-group exposures are not automatically
netted out, this method can produce stricter capital
requirement.

BUILDING BLOCK PRUDENTIAL METHOD

Consolidated balance sheet separated down into its
major firms
Specific capital requirement is calculated for each firm
Requirements are deducted from each firms actual
capital to calculate surplus / deficit
Items deemed non-transferrable are deducted
Specific capital requirements are aggregated and
compared to actual firms capital to identify the surplus or
deficit.

EXAMPLE
Division of Balance Sheet
Banking

Insurance

(Parent)

Securities

Unregulated

(60% ownership)

Full Consolidation
Banking Insurance Securities Unregulated
Capital
required
Actual capital
Surplus
(Deficiency)

Total

42

12

20

12

86

50

15

25

10

100

-2

14

EXAMPLE
Pro Rata Consolidation
Securities
(60%) Unregulated

Banking

Insurance

Capital
required

42

12

12

12

78

Actual
capital

50

15

15

10

90

-2

12

Surplus
(Deficiency)

Total

TOTAL DEDUCTION & RISK-BASED

DEDUCTION
In total deduction method, the book value of the
investment in subsidiaries is deducted from the parents
own capital.
In risk-based deduction method, the capital requirements
of each subsidiary is matched directly against the own
funds of that subsidiary. Surplus, if any, can be used to
augment group capital base.

RISK BASED DEDUCTION METHOD

Dependants investments are fully segregated from
parent capital
Specific capital deficits may also be considered
Adjusted capital is compared to the parents specific
capital requirement

EXAMPLE
Parent
Bank

Capital
investment

Insurance Securities
(60% owned)
15

12
Bank Capital
70

Unregulated
5

EXAMPLE
Specific
capital
required
Actual
capital
Surplus
(Deficiency)

Insurance Securities

Unregulated

Bank

15

15

14

32

18

20

10

70

-4

38

EXAMPLE
Deduction of capital investment in
dependants

Additional dependants deficit

Bank capital

70

Insurance
Securities
Unregulated

-15
-12
-5

Unregulated

-4

Adjusted Bank capital

34

Bank specific capital requirement

Bank surplus capital

32
2

RISK BASED AGGREGATION

Add specific capital requirement of parent and
dependants
Add actual capital held by parent and dependants
Deduct any upstream or downstream capital
Deduct any non-transferrable items
Compare aggregate requirements to aggregated group
capital of surplus or deficit

EXAMPLE
Parent Bank
Insurance Securities
Capital
investment

(60% owned)
15

12
Bank Capital
70

Down
Unregulated streamed
capital
5

32

EXAMPLE
Full Consolidated
Down
Insurance Securities Unregulated Bank streamed
capital

Group
capital

Specific capital
required

15

15

14

32

Actual capital

18

20

10

70

-32

86

Surplus
(Deficiency)

-4

38

-32

10

76

Example
Pro Rate Consolidation
Insurance Securities
Specific
capital
required
Actual capital
Surplus
(Deficiency)

Unregulated

Bank

Down
streamed
capital

Group
capital

15

14

32

70

18

12

10

70

-32

78

-4

38

-32